AC3059 Financial Management

Table of Contents

Question:

Question 1

Zaha Ltd’s equity beta is 1.10.

The market risk premium for South Africa is expected at 5%, and the yield on government bonds currently stands at 7.5%.

Zaha has issued bonds, and its R100 par value bond is currently trading at R94.50.

The coupon rate is 8.

The maturity date is within 5 years and the corporate tax rate at 29%.

In arrears, interest is payable each year.

The coupon interest has been paid by the company for the current fiscal year.

Requirements

Based on CAPM, what is Zaha’s equity cost?

What is the cost of debt after taxes?

Zaha paid R0.12 per share in dividends. The dividend per share will continue to grow at 7% annually.

The share price of the company is R2.30.

How much equity does the company have if it uses the dividend growth model to calculate?

If the target debt-equity ratio for a company is 50%, what is the weighted average cost of capital (WACC).

(As per CAPM, use cost of equity

Question 2

Afroflights is interested in making a takeover offer for Mayfly.

Mayfly earns after-tax profits of R40000 per year.

Afroflights believes that additional money can be spent on investments to increase cash flow after taxes, ignoring purchase consideration.

Year

Cash flow (net tax)

R

Afroflights’ after-tax capital cost is 15%. The company expects all investments to be repaid in discounted terms within five years.

What should the maximum price be paid by Mayfly for its shares?

Is there a maximum price the company should pay for Mayfly shares if it values the business on cash flows in perpetuity? Annual cash flows starting at R120 000 and a sustainable growth rate above 6% are the expected cash flows.

Question 3

Amandla Pty plans to invest in new technology to reduce operating costs, increase energy efficiency, and decrease pollution.

The new technology will be R1 million in cost and will last for four years. At the end it will be worth R100 000.

At the end of the first calendar year, a R104 000 licence fee is due.

In each subsequent year, the licence fee will go up by 4%.

In current price terms, the new technology will reduce operating costs by R5.80 an unit.

The following are the expected production volumes for the lifetime of the new technology:

Year

Production (units/year)

Amandla could finance the purchase of the new technology by taking out a 4-year loan at 8.6% interest per annum.

Below is the loan repayment schedule:

Amandla could also lease the technology.

The company would be responsible for four annual lease rentals totalling R380 000 each year. These rents are payable in advance at each year’s beginning.

The cost of the license fee is included in the annual lease rental.

Amandla can claim 25% tax allowance depreciation if she purchases the new technology.

The company pays 30% annual tax arrears for one year.

Amandla’s average after-tax capital cost is 11% per annum.

Requirements

Calculate the cost of the loan facility to determine whether Amandla should buy or lease the new technology.

(Round the cash flows and discount rate to zero decimal places.

Calculate the net present value (paying the full price immediately) of the new technology using nominal terms. Then, advise Amandla whether to make the investment.

Answer:

Question 1

Below is the relevant formula for CAPM.

Cost of Equity = Risk-Free Rate + Beta*Market Premium

Based on the question, the risk-free rate = 7.5%, beta=1.1, and market premium = 5.5%

Cost of equity = 7.5 + 1. *5 = 13%

Bond par value = R100

Market value of bond = R94.50

Coupon rate =8%, (8/100)*100 =R8

Period of maturity = 5 years

The YTM (Yield To Maturity) of the bond must be calculated by dividing the current market price and the expected future cash inflows.

The following table shows that YTM is 9.43%

Year

Coupon Payment

PV ( R).

TOTAL

Post-tax cost of debt = 9.43 (1-0.29), = 6.7% pa

Let us denote the cost of equity by ke

According to the dividend growth model

Price = Next Year Dividend/(Cost Equity – Growth Rate of Dividends)

Next year dividend = 0.12*1.07 = Rs 0.1284

Dividend growth rate = 7% or 0.07

Price = R2.30

Solving the above equations, ke = 12.58% Pa

It is obvious that 50% of equity is represented by debt if the debt equity ratio equals 0.5.

Equity should be 2X

Then, the debt would be X

Weight of debt = (Debt/Debt+Equity) = (X/3X). = 33.33%

Weight of equity = (Equity/Debt +Equity = (2X/3X = 66.67%).

WACC = Weight of Debt *Cost Tax Cost of Debt + Weight of Equity *Cost of Equity

WACC = 0.3333*6.7 + 0.667*13 = 10.9%

Question 2

2.1 The company should not be willing to pay more than the NPV for Mayfly’s expected cashflows.

The table below shows how this calculation is done.

Year

Cash flows

PV Factor

PV ( R).

Total

Therefore, Mayfly’s maximum price is R101,894.5

2.2 The terminal value of the firm will also be added to determine value of Mayfly.

In the following example, you can calculate the NPV for the firm.

Year

Cash flows

PV Factor

PV ( R).

Total

Therefore, Mayfly’s maximum price is R764,796.8

Question 3

3.1 Initial cost of purchase = R1,000,000 or R1,000,000

R 100,000 is the scrap value at the end after 4 years.

If the company decides to buy, the depreciation applicable over the next four years will be applied.

Further, the following information shows the NPV for purchasing the new technology.

Year

Production (units).

Cost savings

(-) Licence fee

(-) Iniital investments

Incremental profit before taxes

Net cash flows

PV factor

PV cash flows (R)

Below is the PV of cost for leasing new technology

Year

Fee Paid

PV factor

PV ( R).

Total

Below are the PV of Benefits Associated With Leasing

Year

Save!

PV factor

PV ( R).

Total

Leasing NPV = 1375107-1308612 = $66,495

The NPV associated to buying technology is higher than that associated leasing. Therefore, the company would rather buy it.

3.2 In nominal terms, the NPV calculation would use the 11% discount rate and is shown below.

Year

Production (units).

Cost savings

(-) Licence fee

(-) Initial investment

Incremental profit before taxes

Net cash flows

PV factor

PV cash flows (R)

NPV ( R).

The project’s NPV is negative so it shouldn’t be pursued.

How do you place an order?

It takes a few steps to place an order with Us:

  • The first step is to place your order. You will need to provide us with some basic information about your project.
  • Once you have placed your order, you will be taken to our secure payment page.
  • Once we receive your order, we will carefully review it and match you with a writer who has the skills and experience.
  • Stay in contact with the writer and discuss vital details of research.
  • Your completed proposal will be delivered via email within the specified deadline.

You are secure when using our service

It's critical for each client to feel secure. As a result, we at Research Proposal Writing take precautions to secure your data.

Financial security You may securely pay for your purchase using a variety of secure payment methods.
Personal security The personal information of our clients is secure. Nobody else will have access to it.
Academic security We use a specialized program to check every completed paper to ensure that we deliver no-plagiarism samples.
Web security This website is safe from unauthorized breaches. We maintain our privacy management in line with the latest laws and regulations.

You can get help placing your order. If you have any questions about our services, please contact us. Our support staff is accessible 24 hours a day, 7 days a week.

If you're still looking for a way to improve your grades and hire expert writers, we've got you covered. Place an order on our website, and we'll help you with any paperwork you want. We will exceed your expectations.

Order now Get a quote